Foreclosure and Deficiency Judgments

By: Dave Dinkel

Foreclosure and deficiency judgments often go hand-in-hand after the loss of a home through foreclosure. The loss of one's home to foreclosure is often times financially devastating and personally humiliating. But the problems may not stop when the foreclosure process is completed at the auction sale or even if the lender accepts a deed in lieu of foreclosure.

The lender has additional expenses from the foreclosure and for selling a property to a retail buyer after they get it back at the auction. These expenses include the obvious costs associated with the foreclosure including attorneys' fees, lost interest, solution of liens on the property not discharged at the auction, and when it is sold, the realtor®) commissions, maintenance, taxes, utilities, closing costs, etc. The larger loss that can't be passed on to the former homeowner is the loss of the lender's lending ability, and resultant income, because of Federal Reserve cash reserve requirements for the foreclosed property. This loss of lending ability is the reason lenders do not want to purchase homes from foreclosures unless these properties can be sold quickly for a profit. The lender can easily calculate a "final loss" amount that the court system will validate or grant as a "deficiency judgment" against the former loan guarantor - who may not be the former homeowner. In some states this final judgment can be granted from an appraised value instead of an actual sale amount. The appraised value should be contested by the loan guarantor if it appears to be too high.

For accounting or legal considerations, the lender may choose to report the loan deficiency for the guarantor on Form 1099 to the IRS. This gives the former homeowner or loan guarantor a "phantom income" equal to the amount of the loan deficiency and will require he pay income taxes on this amount. In this case the cost of the guarantor's foreclosure will be the amount of income taxes he pays the IRS instead of the entire amount of the deficiency judgment plus additional interest and expenses. This can be a substantial savings to the guarantor and the lender benefits because of a better impact to their financial statement. Usually the lender will issue a 1099 unless they feel there was fraud involved with the original loan.

If a lender accepts a deed in lieu of foreclosure and they make a profit from its sale, they will retain the profit. However, if they lose money, they may be able to issue a 1099 depending on the terms of the original loan agreement and the Acceptance Agreement. It is always wise to have an attorney review any agreement before you sign it to preserve your financial interests. Have the terms of your loan agreement reviewed and any agreements a lender offers you.
Carefully weigh your rights and options when you make a decision to allow your home to be lost as there are solutions besides foreclosure and deed transfer to the lender.

Foreclosures
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